Analysts at Societe Generale went on record this week to say that the current valuation of defensive pharmaceutical operator Shire (LSE: SHP) “makes no sense.” They think the firm is selling too cheap and that we should buy the company’s shares.
The company seems to have fallen out of favour with investors as it digests its 2016 gargantuan acquisition of Baxalta, and the higher debt-load the firm took on seems to be giving investors indigestion when it comes to the shares. But I think something worth holding will emerge from the story and the value is becoming compelling. Growth could follow and the shares will likely turn back up. That’s why I was eagerly awaiting the full-year figures that hit the newswires this morning.
A compelling update
The update is encouraging. Underlying revenue is 32% higher than the previous year, underlying diluted earnings per share pushed up 16% and net cash from operations surged 60% higher. The directors demonstrated their optimism by pushing up the total dividend for 2017 by 15%.
Looking forward, Chief executive Flemming Ornskov thinks the mid-term outlook is positive for growth because of the firm’s immunology franchise, multiple near-term launches, and participation in international markets. He says Shire aims to achieve a revenue target of $17bn to $18bn in 2020. However, during 2018, he expects underlying diluted earnings growth to come in below the rate of revenue growth during 2018, “mainly due to costs incurred from the start-up of our new US plasma manufacturing site, intensifying genericization, and lower royalties.”
A market-wide sell-off of defensive stocks
In addition to the big acquisition muddying the water, I think Shire might have been caught up the wider the sell-off of defensive shares we’ve seen over the past year or so. Today’s share price around 3,141p means you can pick up the stock on a forward price-to-earnings (P/E) rating for 2018 of just eight. I’m tempted to do just that and would consider the firm alongside fellow defensive play Pennon Group (LSE: PNN), the water and waste utility provider.
Pennon’s share price has been slipping, down 29% since June. The firm endured several years of falling earnings but that slide looks set to stop during the current year. In November, the firm reported half-year results showing revenue 5.6% higher than the year before and earnings per share up 7.2%. The directors marked the occasion by pushing up the interim dividend 7.9%.
Earnings look set to turn a corner after the company’s relentless focus on cost control and continuing investment in efficiency improvements. City analysts following the firm expect earnings to lift 13% for the trading year to March 2019 and 10% the year after that. Maybe the wider sell-off of defensive shares is affecting the share-price trend at the very point that Pennon is turning itself around. If so, I think the intersection of a rising growth trend and a falling share price is throwing up an opportunity for investors. At today’s share price around 627p, the forward P/E rating for next year is just below 12 and the forward dividend yield sits at 6.6%. I think that valuation is attractive.
Kevin Godbold has no position in any of the shares mentioned. The Motley Fool UK has recommended Pennon Group and Shire. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.